Ford Motor Company Financial Management Example

1. Does Ford have too much cash? The amount of cash that Ford is carrying on its balance sheet is too much considering that additional money not used for the advancement of the company belongs to the owners of the firm, the shareholders. Having too much cash on its balance sheet will be a disincentive to Ford’s employees who consequently will feel not feel an urgency to perform and add value to the company.

Notwithstanding the fact that the company is always on the lookout for acquisition targets even after already purchasing Jaguar Cars, Volvo Cars, and Land Rover in the past ten years, it is imperative that the company does not engage in such activities for the sole purpose of “empire building. ” Rather, the company should only pursue those companies that will add value to the overall firm. By 2000, Ford extinguished all of their expanding opportunities. By calculating the WACC and subtracting the Interest Earned on their Cash Holdings, we as a group were able to calculate Ford’s Opportunity Cost of Capital.

11. 5% – 4. 79% = 6. 71%. Thus, it is costing Ford 6. 71% per annum to sit on this cash. On the other hand, the fact that Ford’s current, quick, & cash ratios from 1996-1999 are lower than the ratios for its competitors represents a concern in terms of Ford possibly having little wiggle room in relation to paying down its short term obligations. Ford having the higher debt to total asset ratio relative to GM over this period is another cause of unease as using too much debt to pay for its assets can raise the company’s cost of capital.

However, fact that its leverage ratio is lower than GM over this four year period demonstrates the company’s solvency and high market capitalization. Using the full $10B to pay for the Value Enhancement Program as a result will decrease its liquidity further and is also a worry due to the cyclicality of the Auto Industry’s profits. Therefore, it is our recommendation that Ford use a slightly lower cash amount of around $6b to recapitalize the firm’s ownership structure. 2. How does the VEP work?

The VEP would work in that all shareholders would exchange their existing common and Class B shares one for one for new Ford Common Shares and new Class B shares. In addition, they would receive either $20 per share in cash or the equivalent value in new Ford common shares based on Ford’s stock price in late July 2000. If Ford’s pre-distribution price was $60, then one new Ford share would be worth $40, and, subsequently, stockholders would have the choice to receive $20 of cash or half a share of new Ford common. Shareholders could also elect to receive a combination of cash and new Ford common stock with an aggregate value of $20.

Finally, those shareholders not making an election would be treated as if they made a $20 all cash election. If the $20 per share payment would be distributed pro rata to ensure that the company distributed at most $10b. Dividends on the new shares would be reduced such that shareholders who elected stock only would get the same dividend payment on their package as the quarterly $. 50 per share currently being paid. 3. What are the alternatives for distributing cash? There are several methods which Ford can use to distribute its cash reserves.

First, Ford can distribute this money to shareholders by paying them dividends. Paying dividends is the standard way for companies such as Ford to reward its shareholders. Nevertheless, paying dividends is not the most attractive method for rewarding shareholders due to taxation. Dividends in the United States are considered a capital gain; therefore, they are subject to two levels of taxation. One is the federal corporation income tax, which is approximately a 34% marginal tax rate in the United States. However in 2000, for individual taxpayers, the highest U. S.

federal tax brackets for ordinary income was 39. 6%, and for long-term capital gains were taxed around 20%. The other method is through the personal income tax for shareholders. Shareholders are required to report such returns on their income tax statements. The fact that shareholders are taxed twice through this repayment methodology infers that dividends are not their repayment technique of choice. Furthermore, paying out cash reserves through dividends also has the effect of both reducing the company’s assets and also inhibited the company’s ability to fund future growth as Dividends reduce the company’s retained earnings.

The second method to distribute extra cash is through a share repurchase. Share repurchase means a company buys its shares back from the market or from those shareholders who are willing to tender such shares. The buyback methodology is used primarily when companies such as Ford believe that their share price is undervalued. Buying back its stock will help Ford to increase its share price by promoting greater interest in its stock.

However, we cannot effectively increase company’s liquidity through a conventional share repurchase. And also for traditional stock buyback, it usually will take years of time to executive. In Ford case, stock buyback option will put Ford’s family’s voting power in the company at risk. 4. What a problem is the VEP plan designed to solve? Ford’s main reason for designing the VEP was that it believed the company’s shares were undervalued. Ford believed that having its shares undervalued limited its ability to attract, retain, and incentivize employees.

So Ford thought its recapitalization plan would enhance and increase the value of its outstanding shares, provide flexible value, and better align Ford’s management with its stockholders. Additionally, Ford specifically believed that the recapitalization would reshuffle the interests of its shareholders and owners in a way that would further improve the performance of the company. Ford also felt that providing its employees with more equity would incentivize them to improve their performance and create more value for the company.

In addition, Wall Street Analysts suspected that Ford initiated a VEP PLAN, as opposed to a Buyback plan, to better protect the interests of the Ford family, whom had the greatest voting rights in Ford. They felt that this plan would give the Ford family the liquidity it needed in the form of class A shares. This plan was advantageous to the Fords as the Class A shares could easily be sold without having to give up their Class B shares, meaning that the family’s control of the company would not be reduced.

Finally, as part of VEP, Ford announced the Visteon spinoff, which was designed to help Ford and Visteon focus on their individual core businesses. It was expected that this spin-off would further help Visteon create its own customer base that would be separate from the client base of Ford. 5. As a shareholder, how would you approve the VEP? Would you elect cash or shares? As a group we feel that the VEP provides Ford with a healthy way to distribute their excess cash. The VEP also enables Ford to focus on their primary goal: To maximize the value of their Shareholders.

As a group, we calculated Ford’s Cost of Capital for 1999 and further assumed that would not change in 2000. Thus, the PVGO = P-EPS/k = 51. 38 – (5. 86/. 0115) = . 423 (As seen in our excel spreadsheet). Also, by comparing Ford’s P/E Ratio with that of GM and Daimler Chrysler it is evident that the Ford stock is underpriced. We can then assume that Ford’s PVGO is the lowest of the three companies. This low PVGO translates to minimal growth opportunity for Ford and therefore limited projects in which they can allocate their excess cash.

With no growth projects on the horizon, we feel that Ford is essentially obligated to distribute this cash to the shareholders. This cash, in fact, belongs to the shareholders. We have elected to analyze the second half of this problem from three different points of view: The Ford Family, Institutional Shareholders and Common Stock Shareholders. Each party has different needs and desires and thus has generated different conclusions to the question. Common Stock Shareholders: Short-Term Investors: Short-term investors have a shorter investment schedule in relative to long-term investors.

For example, unlike long-term investors, short-term investors are looking to attain a financial advantage that they can quickly capitalize on before cashing their investment out. Thus, depending on their short-term market prediction, they should elect to cash out completely or to receive a combination of cash and common shares. Those who do not expect many growth opportunities for Ford due to the fact they are paying a dividend should remain weary, for the Visteon spinoff may cause the market to think otherwise.

Long-Term Investors: As a long-term investor one focuses on the quality and potential growth of the company they are investing in. With that said, long-term investors should choose to receive additional shares instead of the cash payout. Receiving additional shares could prove highly prosperous for the long-term shareholders, seeing as they have already exemplified their confidence in the company through long term investing. In doing so and taking additional shares, the potential growth that they feel will occur in the future will have a positive and much greater effect on their portfolio.

Institutional Investors: Institutional portfolios require high liquidity. In addition, some institutional investor’s investment income, such as that from a pension fund, is not taxed. Hence, we feel that depending on the qualification of an institution, a100% cash dividend could be a healthy option. However, certain institutions such as index funds may prefer a mixed package of both cash and common shares. Furthermore, these funds must take into account that they will not be taxed until the security is sold, therefore they must plan accordingly. Members of the Ford Family:

The last point of view is that of the Ford Family. The Ford Family’s main concern when considering their decision should be to support their current financial needs without putting their current portion of Class B shares at risk. By focusing on this goal, the family can maintain their voting rights within the corporation. With that said, the Ford Family can choose a full cash dividend or a combination of cash and shares, depending on their monetary needs. Their liquidity needs are mentioned in the case and include situations such as estate disputes, family income as well as divorce settlements.